Small is best as dotcoms wobble on

Smaller companies are providing big returns for investors who have seen some Isas in this sector double in value over the past year. Those unnerved by the recent dotcom rollercoaster ride that saw Freeserve, the internet arm of electrical retail chain Dixons, tumble last week are piling into the relative safety of smaller-company funds. These can still benefit from technology shares, but also carry a wider breadth of growing firms.

Though the UK smaller-companies investment sector makes up only 10% of the London stock market in terms of financial muscle, it accounts for two-thirds of all firms. The sector is made up of firms worth less than £700m each.

But investors must pick carefully because there are still plenty of duds. Small firms were not a great success in the 90s because they were hit hard by the recession and took a long time to recover.

Over the decade, the small-companies sector grew by an average of 12.5% a year compared with 16% for the FTSE 100 and 14% for the FTSE All-Share, according to data collector Standard & Poor's.

Alistair Currie, head of UK smaller companies at Edinburgh Fund Managers, says: 'Throughout the Nineties the Footsie consistently beat smaller companies, with Britain recovering from a recession and investors concentrating on larger firms.

'But big companies have started gobbling up smaller ones, boosting the small-company sector's performance. I believe this will continue as many smaller firms are still undervalued.'

Currie believes prosperity should boost smaller companies for at least another three years, with small high-tech and media firms full of potential. 'I accept UK smaller companies should not be the core part of an investment strategy, but a sensible bolt-on,' he says.

Dan Kemp, a financial adviser with Holden Meehan in London, warns investors not to jump into a smaller-companies Isa without doing their homework on exactly where the fund manager is investing.

'Those that have done very well in the past year have held most of their stocks in technology and media firms, but as we have recently seen, rapid growth can be due to a bubble that eventually bursts,' he says. 'We recommend holding no more than 10% of your portfolio in smaller-company funds.'

Phil Pickersgill, chief executive of laser games supplier Megazone Technology in Leicester, invested in smaller-company Isas a few years ago and plans to increase his investment. He says a Perpetual Isa has grown from £1,500 to £2,600 in four years and a Gartmore Isa from £3,000 to £4,500 over three years. Phil, married to Sue, 29, with daughters Olivia, 4, and Sophie, 2, says: 'A lot of people have been distracted by technology funds.

'Tax breaks announced in the Budget offer an incentive for people to take up share options in their own firm and this may boost values of many smaller companies even more.'

• Sales of technology Isas are at their lowest since October, according to the Association of Unit Trusts and Investment Funds. Sales totalled £165m, 6% of all sales, in May. UK smaller-company Isa sales in May were £72m, up to 2.7% of all sales from a low of 0.9% in April.